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Corporate Code Blue?

Corporate Research E-Letter No. 31, January 2003

CORPORATE CODE BLUE? THE CRISIS OF THE FOR-PROFIT HOSPITAL INDUSTRY

by Philip Mattera

These should be encouraging times for the hospital business. The new Senate Majority Leader, physician Bill Frist, is a member of the family that pioneered the modern for-profit hospital sector and presumably will look out for the industry’s interests. The Bush Administration is launching a campaign to put strict limits on damage awards in medical malpractice cases. Wall Street analysts talk of favorable pricing trends.

Yet whatever good news arises has to compete with headlines about federal investigations, whistleblower lawsuits, multi-million-dollar fines and other features of a series of scandals that have characterized the industry for more than a decade. Long before the misdeeds of corporations such as Enron, WorldCom and Tyco International came to light, hospital companies were being prosecuted for cheating the federal government through their billing practices.

Recent developments include a $631 million payment by industry leader HCA Inc. to settle the latest round of fraud charges brought by the Justice Department. This came just two years after the company agreed to pay the feds $840 million.

Tenet Healthcare, the industry’s number two, agreed last June to pay $55 million to settle civil fraud charges, then saw its stock plunge more than 50 percent amid reports of a new investigation of its aggressive Medicare billing practices. The Justice Department is now suing Tenet for up to $323 million in damages. The company is also facing un uproar over a report released by the California Nurses Association which found that Tenet was taking an average markup of more than 700 percent on drugs it provided to its hospital patients. At the same time, the Service Employees International Union, which has set up a website devoted to the Tenet scandal, is calling for an investigation of the quality of the company’s workers compensation care.

About the only place Tenet has gotten support is from the Neanderthal conservatives of the Wall Street Journal editorial page, who wrote that the real culprit was the “Soviet style price controls” the federal government put in place in the 1980s to control runaway healthcare costs. “Only when Medicare is reformed to respond to market incentives rather than to bureaucratic command and control,” the Journal wrote, “will ‘frauds’ like Tenet sTop happening.” Apparently it is okay for corporations to cheat when the government doesn’t show enough reverence for market principles.

KENTUCKY FRIED HEALTHCARE: THE ORIGINS OF THE HOSPITAL INDUSTRY

Many of the early hospitals in the United States were established as profit-making endeavors by physicians with the backing of wealthy sponsors. Most of these were eventually replaced by so-called voluntary institutions, i.e. ones supported by a religious or philanthropic organization. The growth of these non-profit hospitals was aided by the Hill-Burton Act of 1946, which provided federal subsidies for their construction.

Once the creation of the Medicare and Medicaid programs in the 1960s brought a flood of money into healthcare, some entrepreneurs saw an opportunity. The modern for-profit hospital industry got its impetus in the late 1960s, when Dr. Thomas Frist of Nashville, his son Dr. Thomas Frist Jr., and Jack Massey, one of the founders of Kentucky Fried Chicken, joined forces to create Hospital Corporation of America. HCA, along with its Louisville-based counterpart Humana, began buying up ailing non-profit hospitals or else obtained contracts to take over their management.

Calling themselves proprietary or investor-owned, HCA and Humana, along with some lesser players, grew rapidly by skimming off the most profitable patients—those fully insured people who needed short-term treatment. By 1984 about 1,700 of the country’s 6,800 hospitals were investor-owned.

The halcyon days came to an end when Congress, seeking to control galloping hospital costs, created a standardized system of reimbursement for Medicare patients. The investor-owned chains were also squeezed by the hardball tactics of health maintenance organizations, which many employers brought in to replace traditional health insurance plans.

HCA responded to the crisis by selling off a chunk of its hospitals and by going private in a leveraged buyout (though it later went public again). Humana set up its own insurance plans, and in 1993 it spun off its hospital operations into a company called Galen Health Care, which then merged with Columbia Hospital Corp. Soon thereafter, Columbia combined with HCA to create a $10 billion healthcare leviathan that dwarfed its competitors. By 1996 Columbia/HCA owned nearly 350 hospitals and had about 285,000 people on its payroll, making it the ninth largest non-government employer in the United States.

A HOST OF AILMENTS

By this time the company was also the target of intense criticism of its management practices, which included severe cutbacks in basic services such as trauma care that were heavily used by uninsured patients. Healthcare unions also protested the company’s fierce opposition to organizing drives. Columbia/HCA paid little mind to these charges, but the company grew more concerned in the mid-1990s when the federal government began an investigation of its billing practices. In 1999 the Justice Department brought suit against both Columbia/HCA and Quorum Health Group, a hospital management company that was spun off from HCA in 1989. Two Columbia/HCA executives were found guilty of fraud.

While the federal investigation proceeded, Columbia/HCA’s board took its own action. Controversial CEO Richard Scott was ousted, and co-founder Thomas Frist Jr. was brought out of retirement to preside over a reorganization that included the divestiture of a substantial portion of the company’s hospitals. In 2000 the company agreed to pay $745 million to resolve Medicare civil fraud allegations, and later consented to several criminal counts and a fine of $95 million against two of its subsidiaries. That same year, Quorum agreed to pay $95.5 million to settle its charges and was then acquired by Triad Hospitals Inc.

Columbia/HCA’s travails created a potential growth opportunity for Tenet Healthcare Corp., which had risen to the number two spot. Tenet banked on the hope that the healthcare community had forgotten that in 1994 its predecessor company, National Medical Enterprises (NME), had pleaded guilty to federal bribery charges. In addition, in 1997, Tenet agreed to pay $100 million to settle lawsuits brought by former NME patients who charged that they had been illegally imprisoned in the company’s psychiatric hospitals to obtain their insurance benefits.

Meanwhile, Columbia/HCA attempted a comeback with measures such as renaming itself HCA-The Healthcare Company (later shortened to HCA Inc.), but it found itself hit with new federal fraud charges. By the end of 2002, both HCA and Tenet were embroiled in the controversies described above.

Amid the dubious track record of the hospital industry--along with that of the pharmaceutical and private medical insurance industries--it is remarkable that most public officials and mainstream policy analysts continue to support for-profit healthcare. Back when Columbia/HCA was getting started, it belittled non-profit and public hospitals as inefficient institutions that should go the way of the dinosaurs. With any luck, it will be the corrupt for-profit hospital industry that becomes obsolete.

LARGEST FOR-PROFIT, PUBLICLY TRADED HOSPITAL COMPANIES(ranked by number of licensed beds)